The Value of Economics Analysis in Preparing for Mediation

Philbin, Donald R., Jr., Dispute Resolution Journal

"Why?" the child asks, negotiating a reprieve from eating green beans in favor of an early desert. "Because green beans are good for you," may have a hollow ring. "Because I said so" may work only to the extent of the power imbalance. Children want to know how their parents reach the conclusions that they serve up as positions. They probe for underlying rationales and interests. Litigants have the same need to understand how their opponents reach conclusions.

If 98% of filed cases will have negotiated outcomes, preparing to negotiate or mediate should focus more on underlying rationales than on positions, and for this the parties need a common vernacular through which to discuss the rationales that inform their positions.

This article discusses economic decision analysis as a tool to assist practitioners and their clients in preparing to negotiate or mediate. Of course, an economic analysis is only as good as the legal and factual analysis upon which it is built. It should show the legal remedies allowed by law and the facts supporting them. A sound economic analysis will get a party beyond the simple conclusion that it has a "good case" because there is some chance of a high or low award. A litigant wants to understand how the adversary got to its "good case" conclusion and what "good case" means. Take this military example. An 80% chance of success in each of six crucial stages of a military operation does not make for good odds. Even though a president may be tempted to give the go-ahead if the generals report that the overall chances for the operation are good, the combined results are a surprisingly low 26%. Mathematically, the problem is represented as 0.80 to the sixth power or 0.80 x 0.80 x 0.80 x 0.80 x 0.80 x 0.80 = 0.26. Graphically, it looks like this.

With the facts narrowed and the potential outcomes identified by legal analysis, it is possible to use economic analysis to graphically depict and value various scenarios in a litigated case. While we may not know with certainty what will happen in a specific trial, we do have an idea of the types of results that would flow from trying the same case 100 or 1,000 times. For example, we may get seven heads in 10 coin tosses-a high success rate. But that rate will be quite different (i.e., a "normal distribution") if you tossed the coin 100 times. Just ask anyone who has been to Las Vegas.

Stacking an economic analysis atop our legal analysis will also help us unravel the psychological biases that skew our results. Anchoring, overconfidence, imperfect information, attribution errors, reactive devaluation, and other recognized biases account for noticeable differences in the answers different parties give to the same question. While we may not be able to completely "de-bias" the analysis, we can recognize that the same person will value the same object (house, car, etc.) differently depending on whether she is buying or selling. Plaintiffs and defendants are no different. The legal system essentially forces defendants to write call options that are either in or out of the money depending on the final outcome. The challenge is to rationally derive that strike price in advance. So we account for biases as we build tiered analyses.

Value of Economic Analysis

Intuition and experience can help lawyers and clients gauge the prospect of "winning" a lawsuit. Economic analysis takes this "gut" assessment to another level. It urges a systematic analysis of the different outcomes, from the lowest (zero) to the highest. Once these potential outcomes are determined, they can be depicted in decision trees that MBA students have used for years.

Potential outcomes are not much help until they are assigned a probability of actually occurring. For example, having a chance at winning a $12 million lottery pay off is nice, but it is more helpful to assess the probability of winning, which may be worse than getting hit by lightning. People are likely to have different views on the likelihood of particular outcomes. …

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